If you receive a Schedule K-1 tax form and not sure what you should do with it, it may be beneficial to understand some of the basic tax items that all K-1s report. Regardless of whether the K-1 tax form relates to a partnership, S corp, trust or estate; you should never just ignore it when preparing your tax return since the IRS already has a copy.
Reports Partner Income (Loss)
A business that operates as a partnership isn’t responsible for making income tax payments to the IRS on its business earnings. A partnership does need to file annual income tax returns on Form 1065, but the return is for informational purposes only. Partnership tax rules use pass-through taxation concepts, which mean that partners are responsible for paying income tax on the partnership income that’s reported on the 1065. As a result, partnership accountants must prepare a Schedule K-1 that reports every partner’s distributive share of partnership income, as well as losses, deductions and credits. The partnership must furnish each partner with a copy of their Schedule K-1 tax form, which the partners use when preparing their personal income tax returns. For example, if a partnership earns $200,000 of taxable income and there are only eight partners; the partnership will issue eight K-1 tax forms, each of which report $25,000 of taxable income.
S Corps Use Schedule K-1
A corporation is a separate taxpayer from its shareholders; however, this only applies to C corporations. An S corp is a hybrid entity that has characteristics of a C corporation and a partnership. S corp shareholders, rather than the corporate entity, are responsible for paying income tax on the corporation’s earnings. Just like a partnership structure, the S corporation files an informational tax return, but on IRS Form 1120S. Each shareholder must receive a copy of their Schedule K-1, which must also be attached to the 1120S when filed with the IRS.
Form 1040 Schedule K-1
Trusts and estates file annual tax returns on IRS Form 1041 and in many cases, are responsible for the payment of income tax. However, if a trust or estate must distribute income to beneficiaries or heirs, the recipients of the distribution rather than the trust or estate will report it on their respective income tax returns. When this occurs, the trustee or administrator must prepare a Schedule K-1 to report all distributions to beneficiaries and heirs. And when a beneficiary receives a taxable distribution of income, the trust or estate take a deduction for the same amount on Form 1041 so that it doesn’t have to pay the income tax.
Schedule K-1 Reporting
Schedule K-1s can be a little different depending on the entity that files it. All K-1 tax forms provide information about the character of the income, deductions and losses so that each recipient can accurately report the information on their tax returns. For example, if your K-1 reports dividend income, the person responsible for preparing the Schedule K-1 will separately report your ordinary and qualified dividends.
Reference: IRS Schedule K-1 (Form 1041)